Banks have been chanting “grow or die” and “size matters” for years. But growing only for growth’s sake, or simply because it’s the conventional wisdom, isn’t going to help.
The prices paid to achieve growth, especially among mutual cooperative institutions, almost mandate a certain sized institution. Those above a certain point in terms of asset-size probably have the resources to keep at it. Those below the line, well, probably don’t.
Branching is costly, and rising expenses are already hurting banks – especially the small banks that need growth the most. And in a crowded market like Massachusetts, it takes a certain kind of confidence for a bank to assume it will be able to steal market share from competitors in new and different locales.
Matt Sosik, president and CEO of Webster-based Hometown Bank and former FDIC examiner, said the line between mutual cooperative banks that are able to survive in the long term, and those that aren’t, is currently at about $200 million in total assets.
“It’s obvious. The entire industry knows it, the men and women running these banks know it,” Sosik told Banker & Tradesman. Growing a bank smaller than about $200 million, he said, “is going to be a nearly impossible proposition.”
And according to Sosik, that “line of demarcation” is steadily rising.
“I can go back…and pull those reports out and show you this line of demarcation was over here [at about $100 million in assets] four years ago. If we sit status quo, this line will overtake us.”
On The Margins
Five-branch Hometown Bank is at about $300 million in total assets. It’s well-capitalized, but it can’t simply watch as the minimum size for cooperative bank survival surges past its current abilities.
“We don’t want to grow for growth’s sake. There’s good growth and bad growth, but the reality is we have to grow,” Sosik said. “Then you start to look at branching and there’s a bank on every corner. The point is we need to grow, we know we need to grow.”
As a result, mergers of small banks aren’t necessarily traditional partnerships between one weak and one strong party.
“Mergers aren’t going to be drawn up just on bad events, they’ll be drawn up by two good banks trying to get together to get to scale,” Sosik said.
What gets Sosik’s attention these days is the relationship between non-interest expenses and net interest margin.
For mutual cooperative banks nationwide, non-interest expenses begin exceeding net interest margin below about $200 million in total assets.
For cooperative banks between $201 million and $300 million in assets, net interest margin was 3.29 percent of average assets in 2011. Non-interest expense was 3.09 percent, according to FDIC data.
Cooperative banks between $101 million and $200 million in assets had net interest margins of 2.98 percent and non-interest expenses of 3.09 percent. The smallest cooperatives, those with assets less than $100 million, had a net interest margin of 3.09 percent and non-interest expense of 3.45 percent.
“You’re supposed to make money in this business on the margin. This is core earnings. We need to be able to make money by accepting deposits, paying people for their money and loaning it out,” Sosik said. “When your net interest margin is exceeded by your overhead, you’ve got a problem right out of the gate. These are the numbers we’re all worried about.”
“The efficiency ratios are relatively flat,” he said. “Size matters, and that’s just the way it is.”
Fee Ride
There’s another number that plays an important role in the drama: Non-interest income.
Smaller banks rely more heavily on non-interest income, fees and other expenses charged to customers to help earnings. In 2011, non-interest income accounted for 0.87 percent of average assets among cooperative banks between $101 million and $200 million – but only 0.24 percent among cooperative banks larger than $500 million.
Massachusetts Bankers Association Spokesman Bruce Spitzer said small banks are in danger of being caught up in the anti-fee zeitgeist despite the fact that they are being ordered to spend more and more on compliance, the key non-interest expense item.
“As pressure is placed on small banks to spend increasingly on compliance, coming at a time when the interest rate spread is so narrow, some of those same banks feel compelled to reduce their non-interest income to compete against bigger banks,” Spitzer told Banker & Tradesman in an email.
“Many are choosing to do so,” he said. “There may come a time when they are forced to change direction and, hopefully, consumer activists, regulators and lawmakers as well, will realize that a little- or no-fee strategy is unsustainable.”
For mutuals, there’s no monthly or quarterly pressure from shareholders to show profitability, “but nevertheless, the bar keeps getting raised,” said David Floreen, senior vice president at the MBA. “It’s no secret that cost pressures are escalating on smaller institutions here and across the country…How each institution responds will be different.”
For mutual banks, the problems don’t start next week, or next month, or even next year, Sosik said.
“Even if you’re breaking even, how long does it take you before you run through all your capital?” Sosik asked. “You’re not dividending any of it out. It takes a long time to build up capital in a mutual, but it also takes a long time to chip away at it. So, anybody can run one of these for the next three-to-five years. [But the question is] how do you have the doors open in 20 years or 30 years? How do you look 30 years out and make sure you’re viable?”
